Overnight Funds: ITI Overnight Fund NFO review

Overnight funds are debt mutual funds which invest in overnight securities having maturity of one day. These can be debt or money market securities having balance maturity of one day or overnight securities where issuer (borrower)borrows "overnight" from the investors (lenders). The issuer has to repay the principal amount along with interest at the start of the next business day. The most popular type of overnight securities are Tri-Party Repo (TREPs). The primary objective of overnight funds is to generate returns commensurate with low risk and providing high level of liquidity. As such, these funds are excellent investment options for conservative investors who want to park their money for a few days or weeks with a high degree of capital safety.

Why overnight funds have very low risks?

There are two kinds of risks in fixed income securities, interest rate risk and credit risk. Both these risks are very low in overnight funds, as explained below.

• Interest rate risk: We have discussed a number of times in our blog that price changes of fixed income securities have an inverse relationship with interest rate changes; price of fixed income securities falls when interest rate goes up and vice versa. In the case of overnight funds however, even if the interest rate changes on any particular day, borrower has to repay the money in full along with interest on the next business day. Hence overnight funds have practically no interest rate risk.


• Credit risk: There are two aspects of credit risk. One, the price of a fixed income security falls if its credit rating gets downgraded. Two, the borrowers may default (either interest or principal or both) on their debt obligations causing a loss to the investors (lenders). Both these risks are practically non-existent in overnight funds. Even if the issuer’s credit rating changes, there is no impact on overnight securities because the investor will receive the principal and interest amount in full on the next day. More importantly, the most common overnight security TREPs, are backed by collateral in the form of short term Government Securities, mitigating the risk of default by the issuer. Borrowing and lending in TREPs takes place on a platform run by Clearing Corporation of India (CCIL) which requires the collateral to be short term Government Securities.

Risk / Return trade-off: Overnight funds versus Liquid Funds

Liquid funds, which like overnight funds also invest in money market instruments, have traditionally been the most popular mutual funds for parking short term funds. Unlike overnight funds which invest in securities maturing in a day, liquid funds invest in securities which mature in less than 91 days. Though interest rate risk in liquid funds is also quite low, it is slightly higher than overnight funds which have no interest risk as discussed above.

While liquid funds were considered to be very safe investments in the past, in more recent times, credit risk is emerging as a concern for liquid funds. There have multiple instances over the last 12 months or so, where credit ratings of commercial papers (one of the most popular underlying securities of liquid funds) got downgraded. As per SEBI regulations, debt mutual funds have to mark to market prices of all debt fund securities in their portfolios. Therefore credit rating changes have an immediate impact on Net Asset Values (NAVs) of the schemes including liquid funds.

While liquid funds can potentially give higher returns compared to overnight funds, their risks are also higher. The table below shows various 1 day and 3 day rolling return statistics of Crisil Overnight Index versus Crisil Liquid Index. Regular Advisorkhoj readers know that rolling return is an unbiased measure and shows performance across difference market conditions.

Disclaimer: Rolling Returns from October 1, 2018 to September 30, 2019. Data Source – Bloomberg. Calculations Internal. Returns are annualized

You can see that the rolling returns of overnight and liquid indices support our assertion that though liquid fund can potentially give higher returns, there downside risks are also higher. The difference in average rolling returns of liquid funds versus overnight funds is about 100 bps, but downside risks of liquid fund, particularly over short investment tenures is higher. From a risk / return trade-off perspective overnight funds can be good investment choices for conservative investors.

ITI Overnight Fund NFO

ITI Mutual Fund is shortly launching an Overnight Fund NFO. The investment objective of the scheme is to provide reasonable returns commensurate with low risk and providing a high level of liquidity, through investments made primarily in overnight securities having maturity of 1 business day.The scheme aims to deliver returns in line with overnight call/money market rates. The scheme predominantly will invest in following instruments with 1 day maturity (only an indicative list):

• Tri-Party Repo (TREPS)


• Money market instruments like Certificate of Deposits (CDs)


• Commercial Paper (CPs) and Treasury Bills


• Government Securities and Bonds with 1 Day residual maturity

Why invest in ITI Overnight Fund?

Who should invest in ITI Overnight Fund?

• Corporate /Institutions and high net-worth individuals seeking overnight parking of surplus fund


• Investors seeking highest liquidity, lowest interest rate risk and lowest credit risk product within the fixed income mutual funds category


• Investors with short term surplus funds with investment horizon of1 day to 1 Month

Key Scheme Facts

• Type of Instruments: Debt and Money Market Instruments maturing on or beforethe next Business Day (including Tri party Repo and equivalent)


• Fund Managers: George Heber Joseph and Milan Mody


• Plans / Options: Direct and Regular / Growth and Dividend. Various dividend payout and re-investment options will be available (please read the scheme information document).


• Minimum application amount: Rs 5,000 and multiples of Rs 1 thereafter


• Additional application amount: Rs 5,000 and multiples of Rs 1 thereafter


• NFO opens: October 09, 2019


• NFO closes: October 23, 2019

Summary

Until recently mutual fund investors thought of liquid funds as the safest investment choices. Unfortunately, credit risk related events and SEBI’s mark to market regulation changes may have created doubts, especially for those who were impacted. In this blog post, we discussed that Overnight Funds are by far, the safest investment choice for parking the short term surplus funds and earning commensurate. ITI Overnight Fund, which is going to be launched shortly, can be a good investment option for conservative investors with short investment horizons of a few days to a month or so. Investors should consult with their financial advisors, if overnight funds are suitable investment choices for their very short term investment needs.